Section 409A, the provision of the Internal Revenue Code that regulates the time and form of payment of nonqualified deferred compensation, contains a helpful exception for “short-term deferrals.” Specifically, Section 409A provides that a payment will not be considered nonqualified deferred compensation if the employer makes the payment on or prior to the 15th day of the third month following the end of the employee’s (or, if later, the employer’s) taxable year in which the employee’s right to the payment vests. For individuals and for employers with calendar fiscal years, the key date for purposes of the short-term deferral exception is March 15.
Most employer’s annual incentive programs are structured (or could be structured) to qualify for the short-term deferral exception under Section 409A. For a calendar fiscal year employer that sponsors an annual incentive program which provides that an employee will vest in any amounts earned if the employee is employed as of the last day of the calendar year, annual incentive payments earned in 2021 must be paid on or prior to March 15, 2022 to qualify as short-term deferral payments. On the other hand, an employer that sponsors an incentive program that requires its employees to be employed on the date the incentive payments are paid will almost always qualify for the short-term deferral exception because payment and vesting occur on the same date.